Week 3

Question 1

Consider a 9% APR with semiannual compounding. Which of the following answers is correct?

A. This APR reflects the true amount we will earn over one year
B. This APR corresponds to a six-month discount rate of 4.5%
C. This APR corresponds to a monthly discount rate of 9%
D. This APR can be used as a discount rate to determine the present value of an annuity

Answer 1

B

Question 2

Consider a 9% APR with quarterly compounding and convert this to an EAR.

A. 2.25%
B. 2.57%
C. 9.31%
D. 9.17%

Answer 2

C

Question 3

Whats the face value of a bond?

Answer 3

Amount the bond holder will receive at maturity date

Question 4

Whats the YTM?

Answer 4

The YTM of a bond is the discount rate that sets the present value of promised bond payments equal to the current market price of the bond

Question 5

Whats the coupon rate and how is it calculated?

Answer 5

Used to calculate the constant amount over a period of time that is paid out each period to bond holders

𝐶𝑃𝑁 = (𝐶𝑜𝑢𝑝𝑜𝑛 𝑅𝑎𝑡𝑒 × 𝐹𝑎𝑐𝑒 𝑉𝑎𝑙𝑢𝑒) / 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐶𝑜𝑢𝑝𝑜𝑛 𝑃𝑎𝑦𝑚𝑒𝑛𝑡𝑠 𝑝𝑒𝑟 𝑌𝑒𝑎𝑟

Question 6

Whats the difference between discount, par and premium bond pricing?

Answer 6

• Discount: Sell below Face Value
• Par: Price equal to Face Value
• Premium: Sell above Face Value

Question 7

What are the parameters that have an impact on the bond price?

Answer 7

YTM, CPN rate, Maturity

Question 8

What are the different investment horizons?

Answer 8

Single year, Multiyear, Constant growth

Question 9

Whats the total payout model?

Answer 9

Considers total payout instead of each individual dividend payment separately.

Question 10

Whats the discounted free cash flow to the firm model?

Answer 10

Free Cash Flow to the Firm: focuses on total cash flows to equity and debt holder

Determines the payout to all investors

Question 11

By evaluating cost and benefits using competitive market prices, we can determine whether a decision will make the firm and its investors wealthier. This central concept is called
A) the Law of One Price.
B) the Present Value. 
C) the Valuation Principle.
D) the Internal Rate of Return

Answer 11

C

Question 12

When we express the value of a cash flow or series of cash flows in terms of dollars today, we call it the ________ of the investment. If we express it in terms of dollars in the future, we call it the ________.

A) present value; future value
B) future value; present value
C) ordinary annuity; annuity due
D) discount factor; discount rate

Answer 12

A

Question 13

If we use future value rather than present value to decide whether to make an investment,
A) we will make a bad decision, since the future value will always be higher if the discount rate is positive.
B) we will make a bad decision, since the future value will always be lower if the discount rate is positive.
C) we will make the same decision using either future value or present value.
D) There is not enough information given to answer the question

Answer 13

C

Question 14

Which of the following statements regarding the Law of One Price is incorrect?A) At any point in time, the price of two equivalent goods trading in different competitive markets will be the same.
B) One useful consequence of the Law of One Price is that when evaluating costs and benefits to compute a net present value, we can use any competitive price to determine a cash value, without checking the price in all possible markets.
C) If equivalent goods or securities trade simultaneously in different competitive markets, then they will trade for the same price in both markets.
D) An important property of the Law of One Price is that it holds even in markets where arbitrage is not possible

Answer 14

D

Question 15

Which of the following statements regarding arbitrage and security prices is incorrect?
A) We call the price of a security in a normal market the no-arbitrage price for the security.
B) In financial markets it is possible to sell a security you do not own by doing a short sale.
C) When a bond is underpriced, the arbitrage strategy involves selling the bond and investing some of the proceeds.
D) The general formula for the no-arbitrage price of a security is Price(security) = PV(All cash flows paid by the security).

Answer 15

C

Question 16

Consider two securities, A & B. Suppose a third security, C, has the same cash flows as A and B combined. Given this information about securities A,B, & C, which of the following statements is incorrect?

A) If the total price of A and B is cheaper than the price of C, then we could make a profit selling A and B and buying C.
B) Price(C) = Price(A) + Price(B)
C) Because security C is equivalent to the portfolio of A and B, by the law of one price they must have the same price.
D) The relationship known as value additivity says that the value of a portfolio is equal to the sum of the values of its parts

Answer 16

A

Question 17

Which of the following statements regarding value additivity is false?
A) The value of a portfolio is equal to the sum of the values of its parts.
B) The price or value of the entire firm is equal to the sum of the values of all projects and investments within the firm.
C) To maximize the value of the entire firm, managers should make decisions that maximize NPV.
D) Value additivity does not have important consequences for the value of the entire firm, only on portfolios of firms

Answer 17

D

Question 18

Which of the following statements is false?
A) Financial transactions are not sources of value, but merely serve to adjust the timing and risk of the cash flows to best suit the needs of the firm or its investors.
B) The NPV of trading a security in a normal market is zero.
C) We cannot separate a firm’s investment decision from the decision of how to finance the investment.
D) In normal markets, trading securities neither creates nor destroys value.

Answer 18

C